A lower-risk and cheaper way to bet on a second-quarter comeback in this emerging markets ETF

There’s a new global-related trade starting to wake up as the second-quarter begins and the options prices on it have never been cheaper. Here’s the set-up. The MSCI All Country World Index ETF (ACWI) hit an all-time high last week. ACWI 5Y mountain iShares MSCI ACWI ETF (ACWI) This index would appear to give investors diversified exposure to stock markets around the globe. It includes developing countries, unlike the MSCI World Index, which is tracked by the ETF ‘URTH.’ URTH 5Y mountain iShares MSCI World ETF (URTH) One could be forgiven for suspecting that including developing countries in ACWI versus URTH is a distinction without a (meaningful) difference. Both charts look remarkably similar to the chart for S & P 500 SPR Trust. SPY 5Y mountain SPDR S & P 500 ETF Trust (SPY) There’s a good reason for the remarkable similarity. The U.S. stock market is the 800-pound gorilla of publicly traded equities. Consequently, the US stock market comprises almost 71% of the URTH ETF and nearly 64% of the ACWI ETF. However, when we examine the actual returns of these respective ETFs since April 1st, 2020 through Good Friday — essentially the pandemic plunge low to present— some distinctions in performance emerge. ACWI has had a total return of 98%, URTH 108% and SPY 126% through the end of last week, and the difference in performance is mostly attributable to a remarkable underperformance by emerging market equities. This is illustrated by the MSCI Emerging Markets Index which can be traded with the iShares ETF, ‘EEM.’ EEM 5Y mountain iShares MSCI Emerging Markets (EEM) Over the past 10 years, the total return of SPY is 233%, roughly 10 times the 23% total return of EEM. The trade In the 1987 movie, “The Princess Bride” directed by Rob Reiner, the character Miracle Max played by Billy Crystal explained, “There’s a big difference between mostly dead and all dead. Mostly dead is slightly alive.” Since the mid-January lows below $38, EEM has indeed shown some signs of life, but chasing any equities as markets on the recent rally can be a bit unnerving. Fortunately even as stock markets have gone higher, some options premia have not. EEM three month at-the-money “implied volatility” (how options traders think of an options price) hit a 10-year low last week. What does that mean? It has never been cheaper, as a percentage of the price of EEM to make directional bets on the ETF using options. For example, one could purchase the September $43 calls for about $1.25/contract ($125 in total as each contract represents 100 shares), about 3% of the cost of the underlying. If held until September expiration EEM would need to rally above the $43 strike price by the $1.25 in premium paid, levels unseen in two years. The price chart below shows the regions of profit and loss of the options trade depicted on the right in green and red at expiration The following 6-month chart shows how the call would behave in real-time, so if one manages the trade more dynamically, rather than waiting until expiration to adjust one’s position the trade looks much more attractive. Whether emerging markets truly come back to life, or whether this resurgence over the past couple months is little more than a “dead cat bounce” remains to be seen, but buying a call for $1.25, even if it requires some trade management, may represent a lower-risk way to participate if it continues higher than simply buying the EEM ETF outright after it has rallied $3.40 in the past couple months. DISCLOSURES: (None) THE ABOVE CONTENT IS SUBJECT TO OUR TERMS AND CONDITIONS AND PRIVACY POLICY . THIS CONTENT IS PROVIDED FOR INFORMATIONAL PURPOSES ONLY AND DOES NOT CONSITUTE FINANCIAL, INVESTMENT, TAX OR LEGAL ADVICE OR A RECOMMENDATION TO BUY ANY SECURITY OR OTHER FINANCIAL ASSET. THE CONTENT IS GENERAL IN NATURE AND DOES NOT REFLECT ANY INDIVIDUAL’S UNIQUE PERSONAL CIRCUMSTANCES. THE ABOVE CONTENT MIGHT NOT BE SUITABLE FOR YOUR PARTICULAR CIRCUMSTANCES. BEFORE MAKING ANY FINANCIAL DECISIONS, YOU SHOULD STRONGLY CONSIDER SEEKING ADVICE FROM YOUR OWN FINANCIAL OR INVESTMENT ADVISOR. Click here for the full disclaimer.